Description

After a decade of stagnation, we believe Vivendi shares will significantly outperform over the next 12 months. On a SOTP basis we see at close to 50% upside as the underlying value of the company’s core segments becomes clear.

As you may know, Vivendi is controlled by Vincent Bollore and consists essentially of 4 parts:

• 1.       Universal Music Group

  2.       Canal+

  3.       Havas

  4.       Some cash and various minority stakes in public and private companies

The vast majority of the newsflow for Vivendi centres on its stakes in Telecom Italia and Mediaset (which together are worth €3.9bn or 10% of our SOTP valuation) and the French domestic business of Canal+ (which accounts for another 10-15% of our SOTP valuation).  UMG on the other hand, which accounts for the majority of Vivendi’s value and is its key growth driver, has until recently received very little attention from the investment community and the financial media. This has started to change over the past couple of months as Bollore and his team have slowly begun to float the idea of a partial IPO of UMG.  

We believe that over the next few quarters investors will realise that the acceleration is UMG revenue growth and margin expansion is sustainable. In addition, after 2 years of restructuring,  Canal+ is currently at an inflection point for revenue and earnings growth. As these 2 factors become apparent, investors will have to significantly upgrade their earnings projections which in turn will result in considerably higher SOTP valuations.

Universal Music Group

After decades of decline/stagnation the music industry has started to turn around and begun to experience accelerating rates of growth in recent quarters thanks to the proliferation of music streaming services.  It is worthwhile noting that unlike most other businesses/industries facing long term secular challenges, the decline of the music industry had nothing to do with underlying demand for the product. In fact, consumption of music has continued to grow steadily over time.   The revenue pressure was essentially the result of 2 key factors:

• 1.       Significant increases in piracy in the early days of the internet (Napster, etc)
• 2.       Pricing pressure as a result of unbundling of albums via iTunes

The industry’s shift towards paid streaming is reversing this entirely and brings with it some incremental tailwinds.  For starters, streaming is reducing piracy. Consumers prefer to get their music legally if the price and service is right. Access to any music anywhere for $10/month appears to get this balance right. In addition, emerging market consumers are starting to pay for music again. In China for example, there are 4x as many people who listen to music at least once a week than in the US, yet it accounts for just a tiny fraction of music industry revenue. With the growing penetration of streaming this is changing. A clear proof of this is in UMG’s recorded music revenue geographic split where one can see revenue from Asia growing 12% in 2015 and accelerating to 20% in 2016 after years of decline/stagnation prior to 2015 when streaming services began to gain traction.

Pricing pressure is also reversing. It is estimated that the average iTunes music download customer spends c.$50 per annum. The conversion of this to a recurring $120/year subscription provides a significant ARPU tailwind for the industry. This tailwind will become increasingly apparent over time because the early adopters of streaming were probably the heavier users where there is less of an ARPU uptick (and perhaps even a marginal ARPU headwind) and as streaming gains penetration with more mainstream/average customer profiles, UMG will get a significant ARPU uplift.

In addition to the above drivers, the shift from physical/download purchases to streaming is driving market share gains for the 3 dominant record labels vs the rest of industry. The reason for this is that the part of the ARPU that distributors (Spotify, Apple Music, etc) pay the labels (50-55% of net ARPU) is split among the labels based on consumption.  As many people listen to old music the big 3 labels, which own most of the back catalogue, are getting paid again for music which in the old world would generate very little incremental unit sales.

Lastly, due to the higher ARPU and relative cost advantage (lower production and distribution costs) we estimate that the marginal profitability of streaming revenue is considerably higher, which over time will lead to significant margin expansion.

Making some rather conservative assumptions around the above drivers we estimate UMG total revenue will grow at a high single digit rate for the next couple of years and operating margins will expand by c.200bps per year driving c.25% earnings CAGR  in 2016-2019. This leads to 2019 EBITA of approx. €1.25bn, or EBITDA of approx. €1.35bn. On 15x EBITDA we derive a 2019 value for UMG of €20bn.

Canal+

Whilst many perceive this entire business as structurally challenged, there are actually 4 core components to the Canal+ segment: Free-to-air France, Pay-Tv France, International and StudioCanal. Pay-Tv France is the one that receives all the attention and has undergone significant restructuring over the past 2 years. The 3 other segments have been growing revenue at mid-single digit rates quite consistently.  

Pay-TV France has lost c.15% of its subs since 2012. At the same time it has absorbed significant increases in third-party content costs, primarily French and Champions League football rights. This combination has led to the segment incurring a loss in 2016. However, this is all backward looking.  The business has undergone significant restructuring which included:

·         €300m in cost savings by 2018

·         Complete revamp of the pay-tv packages offered and relevant pricing

·         New distribution deals with Orange, Iliad and Bouygues

Recent data points and comments from management indicate strong progress. At Q1 results the company said subscriber numbers stabilised in March and are expected to start growing again as of July.  95% of customers signed up to the new 2-year subscription which implies that churn should be considerably lower going forward. They guided for FY17 EBITA from Canal+ of €350m, which implies Q2-Q4 EBITA of €300m vs €70m last year. Lastly, in a recent interview,  Canal+ CEO indicated cost savings of €350m by 2018, i.e. an additional €50m on top of the original plan.

Adding the stabilisation, cost savings and telco distribution opportunity of the domestic business to the underlying growth in the 3 other Canal+ segments, we estimate Canal+ EBITDA of c.€900m by 2019. On 10x EBITDA we derive 2019 value of €9bn.

Havas & other stakes

We value the 60% stake in Havas on 10x 2019 consensus EBITDA of €400m, the public stakes (Telecom Italia, Ubisoft, Mediaset, Telefonica and Fnac) at market value of  €6.1n and the whole host of stakes in private companies (including Spotify, Dailymotion, Deezer, Vevo, Gameloft, etc) at €2bn.

We also estimate the company will have €1bn in net cash by 2019.

SOTP valuation

Adding up the above parts we get a total value of €40.5bn. We deduct €1.5bn for the negative value of corporate costs and the minorities in Canal+ International segment to get a SOTP of €39bn or €30/share. After applying a 10% conglomerate discount and adding in the dividend we derive a total return of 47% from the current share price over the next 12 months.

Catalyst

• Upcoming earnings reports shoing further acceleration in growth and margin expansion at UMG
• Canal+ subscriber stabilisation
• Consensus earnings upgrades driven by the above factors
• UMG IPO crystallising the value of this asset